Nasdaq Omx Grp., Inc. v. UBS Sec., LLC

770 F.3d 1010

The NASDAQ OMX GROUP, INC. and the Nasdaq Stock Market LLC, Plaintiffs–Appellees

v.UBS SECURITIES, LLC, Defendant–Appellant.^*

Docket No. 13–2657–cv.

United States Court of Appeals, Second Circuit.

Argued: June 17, 2014.

Decided: Oct. 31, 2014.

Stephen J. Kastenberg (Paul Lantieri, III, William A. Slaughter, on the brief), Ballard Spahr LLP, Philadelphia, PA, for Plaintiffs–Appellees.

Charles E. Davidow (Leslie Gordon Fagen, Daniel J. Toal, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, on the brief), Paul, Weiss, Rifkind, Wharton & Garrison LLP, Washington, D.C., for Defendant–Appellant.

Before: LEVAL, STRAUB, and RAGGI, Circuit Judges.

Opinion

Judge STRAUB dissents in a separate opinion.

REENA RAGGI, Circuit Judge:

On May 18, 2012, plaintiffs, the NASDAQ OMX Group, Inc. and the NASDAQ Stock Market LLC (collectively “NASDAQ”), conducted the initial public offering (“IPO”) for Facebook, Inc. The IPO was one of the largest in history, with 421 million shares of Facebook common stock offered at $38 per share, for a total value of over $16 billion. In conducting the offering, NASDAQ encountered and addressed various problems, prompting a number of subsequent actions, including disciplinary proceedings by the Securities and Exchange Commission (“SEC”), see Order Instituting Admin. & Cease–and–Desist Proceeding, SEC Release No. 34–69655, 2013 WL 2326683, at *2–3 (May 29, 2013) (“SEC Release No. 34–69655 ”), and SEC-approved changes to NASDAQ rules. Among the latter is a new rule subsection establishing a voluntary procedure for NASDAQ members injured in the Facebook IPO to seek compensation. See Order Granting Approval of a Proposed Rule Change To Amend Rule 4626—Limitation of Liability, SEC Release No. 34–69216, 78 Fed.Reg. 19,040, 19,041 (Mar. 22, 2013) (“SEC Release No. 34–69216 ”). Defendant UBS Securities, LLC (“UBS”) chose not to pursue that avenue for relief, instead initiating an arbitration proceeding against NASDAQ seeking indemnification for injuries sustained in the Facebook IPO, as well as damages for breach of contract, breach of an implied duty of good faith and fair dealing, and gross negligence.

NASDAQ initiated this declaratory judgment action to preclude UBS from pursuing arbitration. UBS now appeals from a preliminary injunction to that effect, entered on June 28, 2013, in the United States District Court for the Southern District of New York (Robert W. Sweet, Judge ). See NASDAQ OMX Grp., Inc. v. UBS Sec. LLC, 957 F.Supp.2d 388 (S.D.N.Y.2013). In seeking vacatur of the injunction, UBS contends that the district court erred in (1) exercising federal question jurisdiction in a case presenting only state law claims; (2) determining that the arbitrability of UBS's claims is a question for decision by the court, rather than an arbitrator; and (3) concluding that UBS's claims are not subject to arbitration. For the reasons set forth in this opinion, we identify no error in these rulings and, therefore, affirm the challenged preliminary injunction. Our colleague, Judge Straub, dissents from the ruling as to federal jurisdiction and, thus, does not reach the other two issues.

I. Background

A. The Facebook IPO

NASDAQ is a publicly-traded, self-regulatory organization (“SRO”) registered as a national securities exchange under Section 6 of the Securities Exchange Act of 1934 (“Exchange Act”). See 15 U.S.C. § 78f. It operates “one of the largest national securities exchanges,” executing “approximately 15% of U.S. equity securities transactions every day.” SEC Release No. 34–69655, 2013 WL 2326683, at *1. UBS is a registered broker-dealer and investment adviser, as well as a member of the NASDAQ exchange.

On May 18, 2012, NASDAQ was scheduled to conduct the highly-anticipated Facebook IPO. The initial Eastern Standard start time of 11:00 a.m. was delayed approximately one half hour, largely due to technical difficulties that NASDAQ encountered with the IPO “Cross,” the computerized system that typically launches IPO trading by matching buy and sell orders to determine the opening price. See id. at *2, *5–6. At 11:30:09 a.m., NASDAQ switched to a backup “failover” system that completed the IPO Cross, whereupon “[c]ontinuous trading in Facebook shares then commenced on NASDAQ and other exchanges.” Id. at *7.

The delayed start in trading had certain adverse effects, two of particular relevance here. First, over 30,000 orders entered between 11:11:00 a.m. and 11:30:09 a.m. were not included in the completed IPO Cross. See id. at *10. These orders were dealt with in various ways, including some being cancelled by NASDAQ and others being released into the market at 1:50 p.m. See id. Second, certain trade confirmation messages for orders placed before 11:30:09 a.m. were not transmitted, as a result of which some “NASDAQ members ... were not able to determine whether their orders had been included in the cross and, therefore did not know what position they held in Facebook securities.” Id. at *8. Despite suggestions that it halt trading in the Facebook IPO, NASDAQ did not do so. See id. at *9.¹

B. NASDAQ Rules

In conducting securities trading generally, including the Facebook IPO specifically, NASDAQ operated pursuant to certain internal rules mandated by federal law. Some background as to NASDAQ's internal rules is helpful to our discussion of issues raised on this appeal.²

1. Exchange Act Mandates with Respect to Internal Rules

In order to register as an exchange, federal law requires an SRO such as NASDAQ to demonstrate to the SEC that its internal operating rules satisfy the requirements of the Exchange Act and all federal rules and regulations thereunder. See 15 U.S.C. § 78s(b)(2)(C). The Exchange Act specifically requires that a registered exchange's rules be designed

to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest.

Id. § 78f(b)(5) (emphasis added). The highlighted requirement is of particular significance to this case.

With certain exceptions not relevant here, an exchange must secure SEC approval for every proposed rule or rule change according to a detailed statutory procedure that provides for public notice and comment, possible hearings, and agency findings. See id. § 78s(b), 17 C.F.R. § 240.19b–4. The Exchange Act also provides for the SEC itself to “abrogate, add to, or delete from” an exchange's rules in specified circumstances. See 15 U.S.C. § 78s(c).

The Act makes an exchange's compliance with its own rules a requirement of federal law, see id. § 78s(g)(1), and rule violations can result in SEC revocation of an SRO's registration, censure, or other sanctions, see id. § 78s(h)(1). The Act further requires an exchange to enforce its members' compliance with the Exchange Act, SEC regulations, and the exchange's internal rules. See id. § 78f(b)(1). Moreover, it precludes parties from contracting around, or otherwise waiving compliance with, SEC-approved exchange rules. See id. § 78cc(a).

2. SEC Sanctions NASDAQ for Rules Violations in Connection with the Facebook IPO

The SEC conducted an investigation into NASDAQ's handling of the Facebook IPO, which resulted in the agency sanctioning NASDAQ for violating the Exchange Act by not complying with its own SEC-approved rules. Notably, the SEC found NASDAQ not to have complied with NASDAQ Rule 4120(c)(7), which mandates that trading commence immediately after an IPO “display only period” and limits extension of the display period to specified circumstances found not to have been present in the Facebook IPO. See SEC Release No. 34–69655, 2013 WL 2326683, at *2, *14. The SEC also found NASDAQ not to have complied with its own Rule 4757(a)(1) by failing to adhere to its specified price/time priority with respect to approximately 30,000 orders placed before completion of the Facebook IPO Cross. See id. at *2, *14–15 The SEC further identified an Exchange Act violation insofar as NASDAQ rules did not permit NASDAQ to assume an error position in its own account, an action that, in connection with the Facebook IPO, yielded NASDAQ a profit of approximately $10.8 million. See id. at *14.

To address these and other concerns, NASDAQ agreed, inter alia, to amend Rule 4120 and to make certain technical changes to its IPO Cross system. See id. at *15. The SEC endorsed these remedial proposals but, nevertheless, sanctioned NASDAQ by, inter alia, censuring the exchange, ordering it to cease and desist from violating the Exchange Act's requirement that an exchange adhere to its own rules, and imposing a $10 million civil penalty. See id. at *17.

C. The Parties' Services Agreement

NASDAQ and UBS are parties to a bilateral “Services Agreement,” several sections of which are relevant here.³

Section 12.B of the Services Agreement, entitled “Indemnification,” is the basis for UBS's underlying claim for breach of contract and indemnification. It states as follows:

NASDAQ OMX shall be liable to, indemnify against, and hold Subscriber [i.e., UBS], its employees, directors, and other agents harmless from, any and all Claims or Losses (as those terms are defined ... herein) imposed on, incurred by or asserted against [UBS], its employees, directors, and other agents to the extent that the Claims and Losses result ... from acts or omissions of NASDAQ OMX, its employees, directors, agents or associated persons; or from the receipt or use of [UBS]'s Data (including representations about [UBS]'s Data) by NASDAQ OMX, its employees, directors, or agents

....

A. 136. The referenced “Claims or Losses” are defined in Section 12.G of the Services Agreement as follows:

any and all liabilities, obligations, losses, damages, penalties, claims, actions,

...